Thursday, August 30, 2007

Bruce Bartlett's opposition to FairTax (national sales tax)

I feel like I have a lot in common with Bruce Bartlett. So he has a lot more real-world experience and influence than I do, makes a lot more money than I do, rubs elbows with people who are a lot more important than I do, and...

Ahem! Enough of where we diverge. We have similarities worth mentioning. We both think the Bush Presidency has been bad for the Republican party and the country. We both make a living dealing with the federal income tax structure. We both have problems with the labyrinth governing it, known as the Internal Revenue Code. We don't share the same view of the FairTax (the plan for a national consumption tax to replace the federal income tax), however.

Before delving in, I do not know what rate would be required to truly be revenue-neutral. Bartlett claims it would have to be higher than what is proposed by Congressman Linder and Senator Chambliss (the two guys who have Congressionally sponsored the FairTax in their respective chambers). Estimates of government 'revenues' should be taken as rough approximations, especially when they entail a change in the method of collection. Even when nothing major changes in the tax structure, the predictions are routinely off. This fiscal year, for instance, the Budget Office had originally underestimated total receipts by $39 billion.

Does adding 30% to the price of every house sold sound like a good idea to you?

About three-fourths of sales are of existing, not new, homes. The FairTax would apply only to new goods and services. So only a quarter of houses being sold would be subject to that 30% premium. This is a major factual omission on Bartlett's part, as he is insinuating the tax would be included on 40 million or so home sales each year, instead of the actual 10 million or so that would actually be effected.

He discusses the most conspicuous point of confusion over the FairTax, the debate over whether the tax rate would be 23% (as proponents claim) or 30% (as opponents claim):

In reality, the FairTax rate is not 23%. Messrs. Linder and Chambliss get this figure by calculating the tax as if it were already incorporated into the price of goods and services. (This is known as the tax-inclusive rate.) Calculating it the conventional way that every other (This is called the tax-exclusive rate.) [sic]

The distinction is confusing, but think of it this way. If a product costs $1 at retail, the FairTax adds 30%, for a total of $1.30. Since the 30-cent tax is 23% of $1.30, FairTax supporters say the rate is 23% rather than 30%.

The premium on goods and services indeed would be 30% over their tax-free cost. When you pay $1.06 for a $.99 cent item at the store, the rate of sales tax you're paying is generally thought to be 7%, not 6.5%. That is, the conventionally understood rate is the tax-exclusive rate.

But keep in mind that the FairTax is designed to replace the federal income tax. In contrast to sales tax rates, federal income tax rates are conventionally understood to be their tax-inclusive rates.

If you, as a bachelor, make $5,000 (a low figure for the sake of simplicity), your tax rate is 10%. You owe $500. You are actually keeping $4,500 for your toiling while the government is getting $500. While the government is putatively taxing you at a rate of only 10%, it's taking over 11% of what you actually net.

In terms of the government's total take, then, comparing sales tax rates with income tax rates as each is traditionally understood (one tax-exclusive, the other tax-inclusive) is an apples-to-oranges comparison.

The tax-inclusive trick, like your potential 'refund', is a way of perceptually minimizing the impact of the government's take in the eyes of the taxpayer.

Bartlett's arguing in opposition to the FairTax, so understandably he highlights what becomes more expensive without pointing out what will become less costly:

The FairTax would apply to 100% of services, including medical care, thus increasing their cost by 30%. No state comes close to taxing services so broadly.

Of course, used products from cars to IPods would become more affordable. They would not be subject to any federal tax whatsoever. Additionally, our part-time college bachelor would now have an extra $500 in his pocket to spend on them. And while a trip to the massage therapist will cost a few bucks more, he'll have the $500 extra for it as well.

More generally, the FairTax, relative to the federal income tax, favors the manufacturing sector of the economy more and the service sector less. It also encourages an export-based rather than an import-based economy. Firms providing services rendered overseas (service exports) stand to benefit enormously, as the income derived from the services provided would not be subject to any taxation in the US. Ditto manufacturers who produce in-country and sell abroad.

That is, it encourages people to make money and discourages them from spending it, exactly the opposite of what the federal income tax does. It also encourages people to take better care of and extend the life of products they buy instead of tossing them out with the first scratch and buying a new replacement. Money will move from immediate consumables to capital investment.

He continues by pointing out a problem that Charles Murray has a solution to, even if the scholar has not officially tied his proposal to the FairTax (yet?):

Since sales taxes are regressive--taking more in percentage terms from the incomes of the poor and middle class than the rich--some provision is needed to prevent a vast increase in taxation on the nonwealthy. The FairTax does this by sending monthly checks to every household based on income.

Aside from the incredible complexity and intrusiveness of tracking every American's monthly income--and creating a de facto national welfare program--the FairTax does not include the cost of this rebate in the tax rate.

Actually, the FairTax does not send out monthly checks based on income. Legal residents receive a monthly rebate based on family size (a single guy with no children receives less than a married couple with three kids does). There is no earnings ceiling or phaseout. Income is irrelevant. So that bit about the "incredible complexity and intrusiveness of tracking every American's monthly income" (as is essentially done now, with the self-employed on a quarterly basis and everyone else on an annual one) is bunk. That the WSJ op/ed board let Bartlett make an argument on an entirely faulty premise does not speak well for its diligence.

Does the monthly rebate sound familiar? In principle, it is similar to what Murray lays out in In Our Hands, where he argues for an end to most governmental programs in favor of a simple monthly 'stipend' to all legal Americans. The major difference is one of magnitude--Murray's stipends are upwards to eight times as large as the FairTax rebates. The FairTax might lay the groundwork for what Murray wants. The 'infrastructure' would already be there.

The practical implementation of the plan raises some important questions:

Among the problems: What possible incentive would the states have to be vigorous in their federal tax collections? What is to stop them from slacking off and giving their citizens a tax cut at federal expense?

Legal mandate. Some amount of federal enforcement would be required.

Currently, though, what incentive do I have to accurately report to the IRS the amount of money I made last year? W-2s bind me, but my only incentive (other than a sense of ethical or patriotic duty) is the threat of fines or worse for tax evasion.

What about the work I do on my own, for other individuals? What's my incentive to report that? As it stands, the threat of the stick is laughable. At least with the FairTax, both the guy I performed the work for and myself would have to lie. As it stands now, only I need be dishonest.

The IRS estimates the 'tax gap' to be north of $350 billion annually. Would evasion be lesser or greater under the FairTax plan? Like estimates of total government receipts, it's hard to tell.

Bartlett continues:

What about states with no sales taxes?

There are five small states, representing less than 2.5% of the total US population, that do not currently levy a sales tax (although some cities and counties within them have their own sales taxes). Presumably, they would have to collect on behalf of the federal government. Setting up the necessary apparatus to make this happen would likely lead these states to institute sales taxes of their own.

He also asks:

What's to stop people from bypassing retail outlets and buying their goods from producers or at wholesale, tax-free?

The consumption tax is to be levied on sale to the ultimate consumer. This would not change if I ordered a loveseat factory-direct.

He concludes:

Perhaps the biggest deception in the FairTax, however, is its promise to relieve individuals from having to file income tax returns, keep extensive financial records and potentially suffer audits. Judging by the emphasis FairTax supporters place on the idea of making April 15 just another day, this seems to be a major selling point for their proposal.

Yet all but six states now have state income taxes. So unless one lives in one of those states, this promise is an empty one indeed. In short, the FairTax is too good to be true, and voters should not take seriously any candidate who supports it.

I can do your Kansas return in ten minutes. Depending on your situation, the federal return may take several hours. For those of you who file on your own, do you not save the state return for last? It's dessert. The quick-and-easy final touch to the yearly tedium that you've just slogged through.

It's disingenuous to call the "Make April 15 just another day" slogan deceptive. It is, pithily packaged, their mission statement. The FairTax coalition also wants to end income taxes at the state level. If eliminated at the national level, there would be tremendous pressure at the state level to do the same.

Bartlett does not make mention of it, but a major benefit of a national sales tax is that it severly undermines the attractiveness of illegal immigrant labor. This isn't surprising, as he is a fan of the immigration status quo.

For one, paying people under-the-table becomes a non-issue. Income isn't taxed. So paying the undocumented illegal who shows up at the construction site and goes by the simple name of Pedro $10 an hour no longer confers an advantage over paying John Smith who has a Social Security card, a residential address, and a accessible background the same amount. Both guys pay the same in taxes--it's forked over when they go to McDonald's for lunch and buy a pack of smokes at the convenience store.

Further, because illegals are not entitled to the monthly rebate that citizens are, they go into the labor market at a disadvantage. When the foreman is deciding between Joe and Pedro, Joe bargains for his wage knowing that he has a check for $300 coming at the end of the month.

4 comments:

Nice job of rebutting Bartlett. Keep in mind that prices AFTER FairTax will be similar to prices BEFORE FairTax due to "price efficiencies" that will ensue when the cost of doing business is lessened under FairTax. The 22% tax bloat in prices will disappear as competitors exploit a huge new opportunity to gain market share.

Also, there is no reasonable equity of distribution under the current INCOME tax system. What's more, the TAX CODE has become a TINKERERS' PARADISE for 53% of the lobbyists who game it in Washington DC. It's a lucrative business, and the U.S. TAXPAYER pays for ALL of it in higher prices (a hidden tax which is incomprehensible to the average working person).

So, the FairTax rate on new items would be 29.9% (on the new, reduced cost of items because business isn't taxed under FairTax - thus lowering retail prices by 20% to 30%), or 23% of the "tax inclusive" price tag - this is the way INCOME TAX is figured (parts of the total dollar).

EFFECTIVE tax percentages (that would be paid by comparative "income groups" under the current system) have been calculated by crediting the monthly "prebate" (rebate of tax on necessities) against all likely spending that citizen families (sized 1-member, and greater) are likely to spend. (Dept. of HHS would serve as the basis upon which prebates would be calculated. A single person might receive ~$200/mo. A family of four might receive ~$500 - in addition to receiving their WHOLE paycheck.) According to Prof.'s Kotlikoff and Rapson (10/06),

"...the FairTax imposes much lower average taxes on working-age households than does the current system. The FairTax broadens the tax base from what is now primarily a system of labor income taxation to a system that taxes, albeit indirectly, both labor income and existing wealth. By including existing wealth in the effective tax base, much of which is owned by rich and middle-class elderly households, the FairTax is able to tax labor income at a lower effective rate and, thereby, lower the average lifetime tax rates facing working-age Americans.

"Consider, as an example, a single household age 30 earning $50,000. The household’s average tax rate under the current system is 21.1 percent. It’s 13.5 percent under the FairTax. Since the FairTax would preserve the purchasing power of Social Security benefits and also provide a tax rebate, older low-income workers who will live primarily or exclusively on Social Security would be better off. As an example, the average remaining lifetime tax rate for an age 60 married couple with $20,000 of earnings falls from its current value of 7.2 percent to -11.0 percent under the FairTax. As another example, compare the current 24.0 percent remaining lifetime average tax rate of a married age 45 couple with $100,000 in earnings to the 14.7 percent rate that arises under the FairTax."

"...once one moves to generations postdating the baby boomers there are positive welfare gains for all income groups in each cohort. Under a 23 percent FairTax policy, the poorest members of the generation born in 1990 enjoy a 13.5 percent welfare gain. Their middle-class and rich contemporaries experience 5 and 2 percent welfare gains, respectively. The welfare gains are largest for future generations. Take the cohort born in 2030. The poorest members of this cohort enjoy a huge 26 percent improvement in their well-being. For middle class members of this birth group, there's a 12 percent welfare gain. And for the richest members of the group, the gain is 5 percent."

Thanks. The reduction in compliance costs, especially on the side of the taxpayer, is an additional efficiency result that leads me to think it plausible that in practice, the FairTax would be less expensive to most Americans than the current federal income tax structure is. And it would free up a lot of moderately intelligent accounting and financial planning minds to go into areas of their fields that are more constructive.

Bartlett is a flat taxer. If the code gets worked over it is going to be one or the other. With the flat tax Bartlett can still do all his shelter work. He will remain gatekeeper to the arcane. Consumption is gaining popularity and that's making guys like him nervous. Huckabee jettisoned up in Iowa because of it.

The political winds have shifted so it doesn't matter anyway. The tax war in the next several years will be defensive. Will capital gains top 30%? Forget flat taxes and fair taxes, unfortunately.

Long time. How's Milwaukee? Have you been reading about the Crusades over the summer? I thought they were too nice for all that.

I'm often bemused by the hostility between the flat tax and FairTax camps. The flat tax would be an improvement on the progressive structure, but it wouldn't represent any fundamental change.

A national sales tax will alter the incentive structure in a foundational way. It will encourage working and discourage spending relative to the current system. The economy needs that to be sustainable over the long-term--a perpetual negative savings rate cannot work forever. Also, it would make the US an attractive place for production, and almost certainly alleviate the trade imbalance. The tradeoff will be less immediate domestic consumption of foreign products and services.

Either change would be welcomed. But the entire planning industry would be threatened by the FairTax. I think that's where the genesis of Bartlett's beef lies.